UPDATE 1-Egypt, Israel coordinating on Sinai security sweep-army

* Egyptian army says operation kills 32, 38 arrested

* Israel concerned over heavy military equipment in Sinai

* Fears Islamist militants gaining foothold post-Mubarak

By Marwa Awad

CAIRO, Sept 8 (Reuters) - Egypt and Israel are coordinating
on Cairo's biggest security sweep in decades against militants
in Sinai, in which 32 people have been killed, an army spokesman
said on Saturday, the first clear statement on communication
between the neighbours.

Israel fears Islamist militants, possibly linked to al
Qaeda, have gained a foothold in the Sinai border area since the
overthrow last year of President Hosni Mubarak.

Israeli officials had privately voiced concern about heavy
military equipment being sent to Sinai, which is subject to
restrictions on the deployment of weapons under the 1979 peace
treaty between Egypt and Israel.

Colonel Ahmed Mohamed Mohamed Ali told a news conference in
Cairo that 32 "criminal elements" were killed and 38 suspects
arrested, including non-Egyptians, during the operation which
began on Aug. 7.

"Egypt is coordinating with the Israeli side over the
presence of Egyptian armed forces in Sinai. They know this," he
said.

"The deployment of the armed forces on all the territory of
Sinai is not a violation of the peace treaty between Egypt and
Israel."

An Israeli diplomatic source, who asked not to be
identified, confirmed Ali's comments and said there was a "fluid
dialogue between Israel and Egypt."

An Israeli defence official who also spoke on condition of
anonymity, due to the sensitivity of the issue, said:

"The dialogue between Israel and Egypt is ongoing, as
entrenched in the security appendix of the peace treatise and
channels between both defence establishments remain open."

The sweep began after militants killed 16 border guards on
Aug. 5 in the worst attack since Egypt's 1973 war with Israel.

Ali said the operation "will continue until its goals have
been achieved ... These are not just military goals but also
developmental goals for Sinai."

Bedouin tribes in the area have long complained of neglect
by central government.

Hundreds of troops with tanks, armoured vehicles and
helicopters were sent to Sinai in a joint operation with police
to raid militant hideouts, arrest suspects and seize weapons.

The Egyptian military is replacing some of its heavy tanks
in Sinai with light armoured vehicles, security sources said
this week.

NEW PHASE

But Ali rejected the idea Egypt was pulling out its heavy
equipment in response to pressure from Israel. He said the
operation was entering a new phase that required different
equipment.

"The military operation is in the interest of all sides," he
said.

Asked whether Egypt was coordinating with the United States
over Sinai, Ali said: "Cooperation between Egypt and the U.S. is
strategic, long-standing and goes beyond simple military
operations. However, the military operations in Sinai are
independent, carried out by the capabilities of the Egyptian
armed forces."

Some 31 tunnels used to smuggle goods into the Hamas-ruled
Gaza Strip were also destroyed, he said. The tunnel trade is
central to Gaza's economy which has suffered under an Israeli
blockade on the Palestinian territory imposed in 2006.

The tunnels have also been used to smuggle weapons. "We have
seized arms, rockets, RPGs and automatic rifles," Ali said.

Disorder has spread in Sinai since Mubarak was ousted in a
popular uprising, with Islamist militants stepping up attacks on
Egyptian security forces and the Israeli border. Egypt's new
president, Mohamed Mursi, has vowed to restore order.

"The armed forces will combat thought with thought and arms
with arms. We will only use weapons with those who have
weapons," Ali said.